Although PACE was initially conceived as a mechanism for financing energy-efficiency retrofits for residential property, there is a strong and growing business case for investments in commercial and industrial building retrofits. As a result, PACE programs for commercial and industrial properties are the current driving forces for the nationwide growth of PACE. Studies by several agencies, including the Washington-based U.S. Environmental Protection Agency, consistently show that energy consumption by existing commercial and industrial buildings can be reduced by 25 to 40 percent through a variety of retrofits. Moreover, many types of retrofits can provide attractive returns on investment with relatively modest payback periods. Reliable sources estimate the volume of commercial building retrofits may grow to $15 to $18 billion per year by 2014, up from $3 billion in 2009. Thus, there is a huge potential market for energy-efficiency retrofits financed through the PACE program.
In the industrial sector alone, there are numerous opportunities for achieving greater energy efficiency. For example, the industrial sector in Texas accounts for 19 percent of total industrial electricity consumption in the U.S. Industries, such as refining, petrochemical, cement, steel and manufacturing, consume significant amounts of energy and could enjoy substantial economic benefits from energy-efficiency retrofits. Energy efficiency is important not only from the standpoint of savings in consumption costs, but also with regard to its impact on the demand side of energy availability.
Maintaining reliable energy sources is critical to continued industrial growth. Because of a variety of market and regulatory constraints, there is little likelihood of significantly increasing electrical production capacity in Texas in the near term. Therefore, reducing demand for energy supplies is a critical component of meeting ever-increasing energy needs. By facilitating energy-efficiency retrofits, PACE financing helps drive down the demand side of resource availability. As Tripp Doggett, CEO of the Electric Reliability Council of Texas (ERCOT), Austin, recently noted: “To ensure future electric reliability in the ERCOT region, we need to take immediate steps to address this issue— on the supply side and demand side of the resource adequacy equation. For now, energy use—or “load”—will play a significant role in the near-term reliability equation.”
PACE also has the potential to dramatically accelerate the energy-efficiency retrofit market for commercial buildings. Examples of eligible commercial properties include but are not limited to office buildings, shopping malls, hotels, restaurants, condominiums and apartment complexes. Unlike conventional financing arrangements, the repayment period under the PACE program is frequently tied to the expected useful life of the improvements. In many cases, the repayment period for PACE financing may extend for up to 20 years. The extended term of PACE financing, coupled with the program’s requirement for annual energy cost savings to exceed the total amount of the annual assessment payments, means that retrofits financed under PACE will generate positive cash flows from the outset.
In addition, PACE financing removes the “split-incentive” barrier in buildings with net lease agreements because property taxes generally qualify as a pass-through expense to tenants. The “split incentive” is an issue hindering investment in capital improvements to multi-tenant buildings. For equipment upgrades that provide a return on investment through energy savings, there is a “split incentive” between the landlord and tenants. The landlord often has little to no ability to recover the capital investment in energy efficiency retrofits. Although individual tenants would enjoy the benefit of the investment through lower occupancy costs, they are unlikely to contribute to the cost of capital investments that benefit other tenants and whose payback may extend beyond the remaining terms of their leases. However, with PACE, tenants will reap the benefits of lower utility costs while also paying their allocable share of the assessment costs tied to the upgrades.
The PACE program is a smart way for owners of commercial and industrial properties to finance retrofits for energy efficiency and water conservation for a number of reasons, including the following:
- One hundred percent of the retrofit cost can be financed without utilizing the owner’s credit sources or investment capital for ongoing business operations. There is no additional mortgage debt on the property.
- The PACE loan is secured by the assessment lien on the property and does not affect the borrower’s credit.
- The PACE structure results in positive cash flow immediately because the annual energy cost savings will more than offset the annual assessment costs.
- For multi-tenant investment properties, assessment costs (and associated savings) can be passed through to tenants under existing leases in most cases.
- Ownership turnover is irrelevant because PACE financing follows title to the property. Future owners of the property assume the remaining PACE assessment payments while benefiting from the cost savings realized from the energy-efficiency upgrades.
- By avoiding building obsolescence, retrofits financed under the PACE program help preserve the value of the property.
- In addition to the contractor’s guarantee of the energy savings that will result from the retrofit work, the property owner can obtain energy savings insurance to cover any shortfall in energy cost savings below projected levels.
Yes, PACE may sound too good to be true, yet the approach is real and the word is spreading. In addition to the numerous benefits of PACE financing for commercial and industrial property owners, retrofits financed through the PACE program will produce significant energy savings in the future.
This article first appeared in The Metropolitan Corporate Counsel, a publication that covers legal, regulatory, legislative and business developments.
Online Buzz
Interested in PACE Financing? Learn whether there is a PACE program near you at pacenow.org.